How Bernie Madoff Swindled Billions - Case Study Example

How Bernie Madoff Swindled Billions Prior to 2008, life seemed to be humming along for most Americans. We were living in a rather robust economy where the majority of us were gainfully employed; our houses were worth more than we owed on them; and our investment portfolios were spilling over dividends and other interest payments on our accumulated assets. We were literally living the American Dream. However, we weren’t really sure how we had achieved financial nirvana. We just knew that we wanted to sustain these levels of economic vigor and personal high net worth, regardless of our brokers’ ethics and methodologies to achieve such lofty economic and financial goals. That was before the bubble burst and the cold, stark reality of a market freefall set in, prompting investors and money managers alike to redeem their investments to avoid additional losses in their portfolios. That was before Bernie Madoff turned himself in to his sons, with an ensuing public admission to a $50 billion Ponzi scheme that left many investors, including a handful of mostly Jewish charities, holding the bag and losing their life savings. In December 2008, Madoff made an astonishing admission to single-handedly operating a two-decade-long Ponzi scheme that had left a lot of investors with the startling realization that their investments were full-on exposed to complete financial ruin. According to a study conducted by Clark and McGrath (2009), Ponzi schemes will surface rather frequently in the investment world. This is most likely due to the fact that a stockbroker’s primary duty is to uncover new assets to bring into his or her brokerage for the purposes of management and oversight. As more money is brought in by that particular advisor, the brokerage, who becomes primary custodian of this new money, will in turn reward the advisor with higher commission rates. This incentivizes the broker to diligently pursue more prospects for business. Legally and ethically speaking, there is nothing particularly wrong with this business model. As observed by Lentner (2008), brokerages have been established for money management because, quite simply, people would rather someone else handle stock trades and mutual fund buys and sells on their behalf. The average investor will often feel completely bogged down by the financial rhetoric that is tossed around in the industry. He or she, overwhelmed by such sophisticated verbiage, will typically turn to an expert that can understand market behavior and react appropriately to the normal fluctuation of the market. The experts have been entrusted with other people’s money and must vow to act in a discretionary manner with these funds, constantly keeping the clients’ goals and objectives in mind and effect trades in an honorable manner. The problem with Bernie Madoff is that he took advantage of this investor mindset for his own financial gain. So to describe his behavior during his reign as a top investment advisor as unethical is minimal at best. Madoff is guilty of betrayal. He sold investments to clients that were never put into the market to achieve the consistent double-digit returns that he had promised them. Madoff’s asset management firm was taking in new money from hand-picked clients, claiming to actively trade stocks in his clients’ accounts on a daily basis, which would in turn generate these unprecedented returns by which he had gained such notoriety in the investment world. The reality was that he was taking the new money to repay older tiers of investors that had engaged Madoff for the purposes of realizing high returns that he had guaranteed would remain consistent, through all times in an otherwise fluctuating market. Hence, investors forked over their life savings thinking that they had placed them in the hands of a financial miracle worker, when they were merely donating money to older investors so he could perpetuate his scheme. Besides his professed investment strategy of active day trading in the stock market, Madoff was also courting hedge fund managers to help him recruit new clients and money, thereby stuffing his business pipeline to continue payments to the older investors. According to The Economist (2008), these hedge fund managers, nicknamed in these scenarios as “feeders,” were funneling money to his firm through their own clients, thereby receiving a kickback from Madoff for the monetary transfers into his firm’s discretionary accounts. Once this information came to light, it became increasingly obvious that he could not have acted alone. He needed other sources to help him gain new clientele for the purposes of keeping the scheme from buckling under its own weight. However, even though his scheme necessitated outside sources to prop up his scam, it can be said with confidence that these feeders were a conflict of interest because they received commissions for funneling these funds to Madoff. This structure compelled the feeders to act in their own best interest rather than the greater interest of the clients. Looking back, there was one fatal error committed by each of his investors. There is an investment mantra that we’ve all either recited or have at least heard over the years: never put all of your eggs in one basket. When investing, you want to spread your money around various sectors of the market. According to the College of Financial Planning (2009), this investment concept is Asset Allocation. What the asset allocation model aims to achieve is a balanced portfolio, where money is allocated across several market sectors and asset classes. For example, an investor would take $100,000 and divide it into thirds, with each third invested in a different class: equity (stocks), fixed income (CDs, bonds), and cash. This is absolutely a workable solution, as it reduces the risk of losing everything, should one market sector or asset class take a beating because of some fluke event that was driving down the value of the investment. It is diversification of investments, which means one’s portfolio can quickly absorb the shock of financial loss in a sector because only a portion is affected by that market downturn. It is good financial sense and, if practiced religiously, will keep an investor out of the poorhouse. References Clark, Josh & Jane McGrath. How ponzi schemes work. March 2009. Web. Retrieved 18 April 2011. http://money.howstuffworks.com/ponzi-scheme5.htm/printable College for Financial Planning. (Eds.). (2009). Asset management & investment strategy during retirement. Greenwood Village, CO: College for Financial Planning. Lenzner, Robert. Bernie Madoff’s $50 billion ponzi scheme. December 2008. Web. Retrieved 19 April 2011. http://www.forbes.com/2008/12/12/madoff-ponzi-hedge-pf-ii-in_rl_1212croesus_inl_print.html The Economist. The Madoff affair: Con of the century. December 2008. Web. Retrieved 18 April 2011. http://www.economist.com/node/12818310/print BIO Bernard L. Madoff, an infamous character in the investment world, renowned for his market-making abilities and financial savvy, has now become known across the globe as the ultimate swindler. What began as a legitimate asset management firm, where investors had entrusted Madoff with oversight of their life savings, evolved into a multi-billion dollar Ponzi scheme that left many high net worth clients, institutional investors, and charities absolutely penniless. On December 11, 2008 the world learned that Bernie Madoff had turned himself into his sons and made an astonishing admission to single-handedly operating a two-decade-long Ponzi scheme that had left a lot of investors with the startling realization that their investments were full-on exposed to complete financial ruin. While he promised his clients not only unrealistic returns but also protection from market downturns, Madoff actually sold investments that were never put into the market to achieve the consistent double-digit returns that he had promised them. Madoff’s asset management firm was taking in new money from hand-picked clients, claiming to actively trade stocks in his clients’ accounts on a daily basis, which would in turn generate these unprecedented returns by which he had gained such notoriety in the investment world. The reality was that he was taking the new money to repay older tiers of investors that had engaged Madoff for the purposes of realizing high returns that he had guaranteed would remain consistent, through all times in an otherwise fluctuating market. Hence, investors forked over their life savings thinking that they had placed them in the hands of a financial miracle worker, when they were merely donating money to older investors so he could perpetuate his scheme. Truly his story is a lesson in greed for all of us. Madoff still maintains that he had operated the scheme single-handedly; however, as the investigation is still unfolding, it is becoming obvious that his family and some trusted colleagues at his firm at least knew that he was conducting business on highly unethical levels. However, they were unlikely to ever blow the whistle, as their own financial gain, as a result of their participation, was tremendous. What remains to be seen is whether we, as investors, can overcome personal greed enough to take the good with the bad in the marketplace and begin to make better judgment calls when it comes to where we put our hard-earned money and with whom. Read More